What one big fund is saying about Fannie, Freddie

WASHINGTON (MarketWatch) — It’s been more than five years since Fannie Mae and Freddie Mac were placed into conservatorship, but the reform process has been opaque and the stakes are too high to get it wrong, says the investment research director at the mutual fund that has taken big stakes in the housing finance giants.

Dan Schmerin is investment research director at Fairholme Capital Management, which owns more than 150 million common and preferred shares in Fannie and Freddie, and spoke to MarketWatch about the firms’ future.

Fairholme proposed a private recapitalization of Fannie and Freddie, but the Obama administration signaled that the plan was a no-go. Fairholme is also suing over a 2012 amendment to the government’s bailout agreement for Fannie and Freddie that forces the housing-finance giants to send all of their profits to the U.S. Treasury Department.

Fannie and Freddie’s futures remain unclear. U.S. lawmakers disagree over the role that the government should play in the U.S. housing-finance system. Also, with the recovery of the housing market, Fannie and Freddie have become cash cows, and some say the will to advance meaningful legislation is dimming.

MarketWatch: A U.S. Treasury official recently said Congress’s lack of progress on reforming the U.S. housing-finance system shouldn’t be “an excuse” to delay rebuilding the market for private-label mortgage securities. Has the administration given up on housing-finance reform?

Dan Schmerin, Fairholme’s director of investment research

Schmerin: It’s not entirely clear to us what the administration’s plan or strategy is with respect to reforming the GSEs. Aside from publishing a white paper in 2011, their thoughts, recommendations and viewpoints on GSE reform have really been few and far between. The president recently articulated, as you know, a few very high-level guiding principles, which are subject to significant interpretation and also subject to immediate disagreement from leaders within his own party.

MarketWatch: What does the lack of certainty and progress mean?

Schmerin: There is a growing recognition of the vital role that Fannie and Freddie play in our secondary mortgage market and the tremendous difficulties that our nation would face if one were to effectively abolish Fannie and Freddie with the hope of rebuilding other firms or a consortium of others firms to try and fill the void.

Our sense is that as more and more elected officials are examining the complexities inherent to this topic, they’ve realized that broad and sweeping reform, which may sound attractive, is actually very challenging to effectuate because the risks of getting it wrong are significant.

If you do away with Fannie and Freddie, congressional officials need to come forward and say: ‘We’re OK with doing away with affordable mortgages. We’re OK doing away with the 30-year fixed-rate mortgage and we believe our constituents will accept and understand that the availability and liquidity in the secondary mortgage market will be fundamentally different to their detriment going forward.’ Because those are the facts.

MarketWatch: Would it be such a bad thing if 30-year mortgages weren’t such a large share of the U.S. market?

Schmerin: An overwhelming majority of Americans demand the 30-year fixed rate. An overwhelming majority of Americans want the financial certainty that comes with fixed-rate payments and slow amortization over the lifetime of that mortgage.

We can certainly transition to a system that’s strictly adjustable-rate mortgages, but it’s not our sense that that is in the national interest.

Americans want, on a per capita basis, the highest quality homes, the largest availability of homes and, in terms of size, the largest square-footage homes. For all the perceived ills with our housing-finance system, we are all lucky in that in America we’ve achieved most of those objectives. That’s not to say that there aren’t high quality homes in other developed countries around the world. But they’re not as large, they’re not as easily available, on a per-capita basis, and most of them, frankly, aren’t as nice.

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